Why the Euro Still Matters to US Financial Markets

By Chad Karnes

Published November 02, 2012

ETFguide

One week Europe is a mess, the next week Europe's problems are solved. And because of the hurricane damage in the Northeast along with the U.S. Presidential election, Europe has take a temporary back seat in the news. Does this mean it is no longer important to our financial markets?

In an article I wrote on 10/3, the importance of the Euro and how its movements are driving US stock prices, not earnings or other factors, was captured by one simple chart. That updated chart is below.

The chart also shows the more things change, the more they stay the same. The Euro's tracking ETF (FXE) continues to be highly correlated and the primary driver of the US stock market's direction.

The Tail that Wags the Dog?

We live in a continuously more interconnected and global world. Proof is shown by the immense size of foreign transactions with over $4 Trillion traded on the currency markets every day.

By comparison, the New York Stock Exchange (NYX), the largest stock exchange in the world, trades just $150B each day, roughly. That market is 3x larger than its nearest competitor, Nasdaq (NDAQ). The top 10 stock exchanges in the world trade an estimated $375B collectively each day.

This means the Foreign Exchange market is over 26x larger than the NYSE and over 12x larger than all the world's major stock exchanges put together. To call the Forex market the much bigger brother of the equity markets is indeed an understatement. Given the correlations and size differences between the two markets, it is very safe to say that the currency market is the dog that wags the tail of equities.

Where is the Euro (and thus the Equity Markets) Headed?

We have been long-term bearish on the Euro. In our January Newsletter, published 12/16/11 and when the Euro was trading around $1.31, we stated, "As long as the euro remains below its ascending trend line, we expect prices to fall further. A rally back towards the trend line (then at $1.3250) would likely be another opportunity to reload short positions." That indeed occurred when the Euro rallied in the spring to its trend line before falling another 10% to its July low of $1.21.

More recently, in our November ETF Profit Strategy Newsletter published 10/19/12, we advised our subscribers, "The Currency Shares Euro Trust (FXE) broke to a near term high of $130.50 in September and double-topped this week. The $131-$132 range is an area of stiff upward resistance". We also identified a level where the Euro can be shorted again. Price is now very close to confirming that short.

If the Euro's downtrend is confirmed, we also expect the equity markets to keep up their high correlations with the Euro, continue to be the Tail of the Euro dog, and sell off alongside. The implications also would affect other markets such as the Dow Jones Industrial Average (NYSEArca:DIA), long term bonds (NYSEArca:TLT), and commodities such as Silver (NYSEArca:SLV) and Gold (GLD).

The ETF Profit Strategy Newsletter filters through the unhelpful media noise by utilizing comprehensive technical and fundamental analysis to keep us on the right side of the markets. A few times each week we update our subscribers on actionable high probability trading setups that identify stops and profit targets like those of the Euro and its tradable ETFs.

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